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Saturday, October 18, 2008

Credit Tightening Continues as Inflation Falls Back Steadily

Inflation is no loger the greatest threat to the short term health of the Indian economy. The global credit crunch has now taken over poll position on the list of worries which are likely to determine the evolution of policy over at the Reserve Bank of India. India's inflation continues to slow and hit a four-month low at the start of October, giving the central bank room to keep injecting cash into the financial system without fanning prices.

Wholesale prices rose 11.44 percent in the week to Oct. 4 from a year earlier after gaining 11.8 percent in the previous week, according to data from the commerce ministry last week.

Weaker price gains and a shortage of money in the banking system have allowed the central bank to shift its focus from fighting inflation to stimulating an already slowing economy. The Reserve Bank of India on Thursday lowered the amount of deposits that lenders need to set aside for the second time in a week to ease the worst cash shortage in the economy since 2000. The central bank reduced its cash reserve ratio to 6.5 percent from 7.5 percent, a move which will add 400 billion rupees ($8.2 billion) to the financial system. India also accelerated loan payments to banks and doubled the overseas investment limit in corporate bonds to shore up the rupee from near a record low. Until the reduction in the cash reserve ratio which started just over a week ago now the Reserve Bank had increased its repurchase rate by 3 percentage points to 9 percent since 2004 and the cash reserve ratio by 4 percentage points since December 2006. The central bank's next monetary policy statement is due to be released in Mumbai on Oct. 24.

India thus joined Brazil and Russia in injecting funds into commercial banks to tackle the global credit crunch, this is viewed to be a less riskier route at this point than intrioducing interest rate-cuts, and it is hoped it may also prove to be a more effective way of getting liquidity quickly through to the corporate sector.

India has injected one trillion rupees ($21 billion) through reserve requirement cuts since Oct. 11 as call money rates surged and mutual funds sought government help to meet the highest redemptions by investors this year. The central bank's moves to inject liquidity helped push down India's call rates to 7 percent today from an 18-month high of 16 percent hit on Oct. 10.

Finance Minister Palaniappan Chidambaram also increased interest rates on deposits by non-resident Indians and doubled the overseas investment limit in corporate bonds to $6 billion to shore up the rupee from near a record low.

The extra yield investors demand to own developing nations' bonds instead of U.S. Treasuries fell 17 basis points to 6.06 percentage points, according to JPMorgan Chase & Co.'s EMBI+ index. The yield on bonds rises, as the value of the underlying bond falls.

Oil and Commodities Continue To Fall

Oil prices recovered some ground Friday, rallying above $71 a barrel on speculation that OPEC could slash output in an effort to stop crude's downward spiral. Light, sweet crude for November delivery rose $2 to settle at $71.85 a barrel on the New York Mercantile Exchange after earlier rising as high as $74.30. On Thursday, prices lost $4.69 to settle at $69.85 a barrel. Despite Friday's modest rally, oil is still down $75 — or 51 percent — since catapulting to a record high of $147.27 on July 11.

Commodity prices fell during a volatile week, with the Reuters/Jeffries CRB Index of 19 raw materials from coffee to silver, dropping 3.6 per cent amid concerns that the global economy was heading into recession. The abrupt falls in commodities - the RJ-CRB index hit its lowest level in four years - engulfed gold , which ended yesterday at a one-month low of $775 a troy ounce,

Steel prices as also falling rapidly, as industrial and construction demand drops sharply. Tata Steel Ltd., India's biggest steelmaker, has announced itwon't raise prices for six months or cut output if the government imposes an import tax and scraps levies on exports of the metal.

Companies are seeking 15 percent import duty and scraping of the export levy as demand weakens, Minister Ram Vilas Paswan told reporters after meeting executives in New Delhi today. They also want excise tax to be lowered to 8 percent from 14.4 percent.

Slowing demand from manufacturers and builders is driving down steel prices and forcing producers including ArcelorMittal, and Corus, the U.K. unit of Tata, to consider output cuts. Global steel production and consumption may slump 5 percent in 2009, Research & Consulting Group AG said Oct 9.

Foreign Exchange Reserves

India's foreign exchange reserves fell $9.94 billion during the week ending October 10, 2008 to $274 billion mainly because the Reserve Bank of India continued to sell dollars to try to contain the steep depreciation of the rupee.Forex reserves fell by another $9.93 billion (to $274 billion) during the tumultous week ended October 10, 2008 following the $7.8 billion fall of the previous week. .

India — the fourth largest holder of foreign exchange reserves in Asia after China, Japan and Taiwan — has seen reserves sliding since the start of this fiscal year. Since hitting a peak of $316.17 billion during the week ending May 23 this year, reserves have dropped by $42.17 billion. , forcing policymakers to unveil measures such as higher investment limit for foreign institutional investors (FIIs) in corporate debt and allowing banks to offer higher rates on NRI deposits to boost inflows. The situation now stands in stark contrast to the same period a year ago, when reserves rose by $57 billion.

The revaluation of the foreign currency assets also contributed to the steepest-ever weekly fall. In the previous week foreign exchange reserves had declined by $7.8 billion, which was also a weekly record. Overall, reserves have fallen by nearly $18 billion in a fortnight.

In rupee terms, India's foreign exchange reserves, however, rose by Rs 2,258 crore during the week ending October 10 to Rs 13,33,424 crore. In the financial year, the increase is to the tune of Rs 95,459 crore. India's merchandise exports, which were estimated at $250 billion in 2007-08 are, for the time being, well covered.

In recent months, foreign institutional investors (FIIs), which are facing financial pressures at home , have been selling in the Indian markets and repatriating money. In calendar 2008 so far, FIIs have been net sellers of $10.83 billion in the equity market. FII sales have put pressure on the rupee, which has dropped 22.96 per cent against the dollar since January. This has prompted RBI to intervene heavily in the forex markets.

Stocks Fall

Indian stocks fell, with the benchmark Sensitive Index declining to its lowest in more than two years on speculation that overseas funds faced with redemptions are selling the nation's equities. Reliance Industries Ltd. tumbled 6.2 percent to its lowest since March 16, 2007. Infosys Technologies Ltd., the software developer that gets more than half its revenue from the U.S., fell 4.8 percent to its lowest in three years.

The Bombay Stock Exchange's Sensitive Index, or Sensex, fell 606.14, or 5.7 percent, to 9,975.35, its lowest since June 20, 2006. The benchmark posted its fourth weekly decline, falling 5.3 percent. All 30 stocks in the index dropped. The S&P CNX Nifty Index on the National Stock Exchange dropped 194.95, or 6 percent, to 3,074.35. The BSE 200 Index lost 5.1 percent to 1,201.95.

India's MCSI Core Stock Index was down 4.45% on the day on Friday, after falling 26.7% so far this month, and 63.44% so far this year. But India is far from alone here, since the MSCI Emerging Markets Index plunged by 28 percent this month, with Russia's Micex Index alone falling 42 percent.

Overseas investors sold a net 8.41 billion rupees ($172 million) of Indian equities on Oct. 15, increasing the outflow this year from stocks to a record $11.1 billion, according to India's stock market regulator.

The Rupee

India's rupee fell to a six-year low as the benchmark equity index slid below 10,000 for the first time since June 2006, stoking concern capital outflows will quicken. The currency completed a 10th weekly loss. The rupee in part dropped on concern measures taken by global central banks and governments won't be enough to stave off the credit crisis.

The currency fell back0.8 percent this week to 48.8825 a dollar at the 5 p.m. close in Mumbai. That is the lowest since June 2002. The currency's 10-week losing streak is the longest since December 2005. The rupee has fallen 19.4 percent this year, the most since a balance-of-payments crisis in 1991 forced the nation to pawn its gold with the International Monetary Fund to pay for imports. It is poised for the first annual loss since 2005 as overseas investors pulled out almost two-thirds of the record $17.2 billion they invested in Indian equities in 2007.

Disclosure Statement: Edward Hugh is a macroeconomist who maintains a premier set of blogs at Global Economy Matters and is a featured analyst at Emerginvest. Edward Hugh provides non-partisan information about world stock markets, and does not have any holdings in foreign equities. The information stated above should not be construed as investment advice, and Edward Hugh is not liable for any actions taken on said materials.

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